At the risk of turning this into a parenting thread, I used to do this with DD when she was little as well, and it worked like a champ.

"Mommy, you're mean!"

"Yes, I am. There's a competition for meanest mommy in the world, and I want to win it!"

"..."

Oh....the Meanest Mommy in the World (MMW). I've always loved that one and fully embraced and gloried in the title. Here's my little addition. We were visiting with DSiL's family. Her DS, my DNephew (age 8 or 9) pulled that line on her. I immediately jumped in with a very theatrical performance along the lines of: "What? That can't be!!! I'm the MMW. DN looks at me (aka "The Fun Aunt") with total incredulity. I could just see him thinking, "Huh? How can my Fun Aunt be the MMW?" I wait a beat or two then say (also very theatrically) that we are going get my DS (age 24, aka "The Coolest Cousin on the Planet") on the phone, right now, and he will tell DN just exactly who is the world-record holding "MMW, because there can only be one....and it's me." Situation totally bean-dipped and defused.

What has NEVER worked for me? The "killing them with kindness" or "being the bigger person" strategies. In my experience, those strategices backfire as they actually make such people MORE demanding and entitled because they see you as a doormat and ripe for the plucking.

What has worked: Setting up firm boundaries and never ever giving an inch. Sadly, with this type of person, you simply should not EVER given an inch because the minute you do, you've reset the game to the start and you'll have to work on setting up those boundaries all over again as if they never existed.